18.12.2020 | Market insights: a fuel that fills the gap between fossil and renewables energies
The shift away from coal and towards climate neutrality is in full swing. In this context, natural gas in general and LNG (Liquefied Natural Gas) in particular, are becoming increasingly important on a global scale. Axpo expert Andy Sommer, Team Leader Fundamental Analysis & Modelling, gives some insights in this special report on what role natural gas will play in the coming years.
The world is slowly starting to move towards the goals defined under the Paris Agreement. Back in 2015, 196 countries signed the Agreement to keep the increase in global average temperatures to well below 2°C above pre-industrial levels. A few countries, such as Switzerland, South Korea and Japan, are aiming for climate neutrality by 2050. China has announced a goal to be carbon neutral by 2060. European Union member states are currently negotiating an exact timeline. Many large international companies, such as Mercedes-Benz, Maersk, Danone and Starbucks are advancing towards climate neutrality as well.
What does this mean for energy markets, and especially for natural gas? Is it realistic to assume that renewables will cover all energy needs in the future? And if so, will gas-fired power plants and pipelines end up as stranded assets?
Besides subsidies for renewable energy technologies and the forced closure of old and dirty coal-fired power plants, one of the most powerful tools to control greenhouse gas (GHG) emissions is considered to be a price tag on emissions. The theory is that high emission prices will raise the operating costs of emission-intensive operations, such as coal-fired power production. Lower emission technologies, for example gas-fired plants, will become more profitable by comparison. This creates a window of opportunity for gas. Emission-free technologies will not feel a financial burden at all, but are currently often still too expensive to build in the required capacity.
The European Union currently runs the Emissions Trading System (EU ETS), designed as a marketplace to buy emission allowances for specific sectors out of an ever-shrinking supply pool. China is currently planning to rollout a similar nation-wide ETS by 2024. In addition, South Korea, Germany and other nations already impose taxes on GHG emissions within certain sectors.
However, the number of countries working under, or planning such schemes is currently still very low. This lack of action has meant relatively low-cost coal has remained the favoured means of electricity production in many regions, especially in Asian countries where population and economic growth is high and comes with a corresponding demand for energy. Therefore even the recent decline in gas prices and installation costs for renewable energy technologies has not been able to slow the overall increase of global GHG emissions.
With 42%, the electricity sector is the largest single contributor of global greenhouse gas emissions. But other sectors combined emitted 58% of the total in 2018. The transportation sector emitted 25% of the 33.5 billion tonnes of GHG produced. Manufacturing industries are close behind, with a 19% share.
International Energy Agency (IEA) statistics show three important trends. The “energy transition” in Europe has helped reduce carbon emissions on the continent by 15% between 2010 and 2018. The shale gas revolution in the US cut emissions by about 7%. But non-OECD Asian GHG emissions grew by more than 25%, or 3 billion tonnes, over this time period.
Axpo expects carbon prices in the EU to rise strongly in the coming years. Other countries and regions are likely to follow suit by pricing GHG emissions in one way or another as well. Since we can anticipate the installation costs of renewable energy technologies to decline further, we agree with the IEA’s assumption that low-carbon technologies will be the exclusive driver of net primary energy demand growth globally until 2030 and even beyond.
However, we also believe that natural gas will play a very important role in the current energy supply environment.
For one, Europe will continue to phase out coal in the coming years, and a similar trend is emerging globally. Coal demand appears to have peaked in the past decade. This factor, coupled with continued global economic growth, and faster paced increases in energy consumption, means low-cost and abundant natural gas will be an important and growing part of the energy supply mix, despite global nuclear power and renewable energy capacities being forecast to rise strongly in the decades ahead.
Secondly, renewable energies cannot yet offer a reliable solution because they have an intermittent production profile. Building interconnectors and developing sufficient battery capacity to bridge prolonged periods of low wind or reduced sunshine will take time. Gas plants are in a prime position to provide a stable supply of electricity in a highly flexible manner.
And thirdly, reaching a net-zero carbon world requires significant decarbonization in other sectors, most of all transportation and manufacturing. A technology to help with that is already available; we will see strong growth in the mid and longer-term use of hydrogen. Although a green form of hydrogen – produced with electricity from renewable sources – is clearly the preferred option, wind and solar capacity will likely need decades to meet the levels of supply required. A cheaper and amply available option, is to use natural gas in the hydrogen production process, best in combination with a carbon capture and storage (CCS) technology, known as “blue hydrogen”.
Liquefied Natural Gas (LNG) has long been seen as the fuel to bridge the gap left after higher polluting fuels like oil and coal decline in favour of renewables. LNG is also a way to monetise stranded assets and provide stranded power markets with a relatively inexpensive and lower carbon fuel supply.
LNG trade reached 355 million tonnes per year (mtpa) or 5300 TWh equivalent in 2019, with the market growing 13% y-o-y following an investment spree in the early 2010s when oil and gas prices were high. Several years of supply growth since 2015 has led however to supply capacity growing faster than demand. Recent headwinds from the US shale revolution have reduced global energy prices, and the Coronavirus pandemic has cut demand outlooks. Growth in LNG trade is therefore predicted to slow dramatically between 2020 and 2024 because of low investment in new projects and long delays. However, from the mid 2020s, growth in LNG demand will continue, and rise again, particularly in North East Asian and South Asian markets where incentives will drive a reduction in carbon emissions. In these markets, a considerable market share remains with the oil and coal industries, so LNG is viewed as a bridge to renewable sources when costs fall in years to come.
In Europe, while there will be a substitution of gas for coal, lignite and nuclear in the power markets, the gas share will not grow as quickly due to the rapid rise in renewable capacity offsetting losses elsewhere. Instead, LNG is seen more as filling the supply gap amid declining domestic production in the UK, the Netherlands and to a lesser extent Norway but also with uncertainty surrounding political pressure on Russian gas imports. Lower gas supplies could require LNG imports to rise from around 2022 compared to 2018 levels (when the LNG market was last balanced), and would support global LNG trade growth, which is expected to almost double by 2040, reaching 700 mtpa (10400 TWh).
Author: Andy Sommer, Team Leader Fundamental Analysis & Modelling